The main aim of the report is to shed light on the financial performance of GKN Plc. The evaluation will be done considering the four major areas that are liquidity, profitability, efficiency, capital structure and the market performance. The four different area will enable to evaluate how much profit the company will make every year and importantly the operations in the four years so the position of the company can be ascertained. Further, the limitation of the analysis is discussed.
GKN has spread its business on a global perspective. GKN is concerned with the traveling and whenever one travels, GKN is likely to be traced. It is involved in design, manufacture, and system servicing, as well as servicing the elements for the manufacturers of original equipment around the globe (GKN, 2016). The company is regularly trying to evolve new technologies and rediscover the ones that are existing so that a better scenario is visualized. As a matter of fact, it contains network surpassing 58,000 employees that stretch over 30 countries and the presence of technology,
innovative ideas and solutions helps the company to cater to the need of the customers (GKN, 2016). The company has more than 160 manufacturing facilities, service centers, as well as offices that cover more than 30 countries. The main reason for the success of the company lies in the flexible nature and adaptation to the changes in the environment. The company never hesitated to any change and this is the sole reason why it is a successful company. It has lived in the reality and therefore, occupied a string place in the global industry.
Performance Analysis
Performance analysis is vital as it helps in knowing the past performance of the business and hence, enables to take a stand on the financial solidity of the business. This ratio helps in monitoring and accessing the changes that happened in the business (Graham & Smart, 2012). The profitability ratio is of utmost help to the investors, as well as shareholders because it enables them to know how efficiently the company is operating to generate profit from the assets and investments.
1. Profitability of GKN Plc
The profitability is computed under various ratios, the majorly are the net profit and gross profit margin. A company strives to ensure profit with the capital that is employed into the business that helps to understand the volume of profit generated and the profit margin can be evaluated over here to take a stand to invest more or move to a new company (Davies & Crawford, 2012).
The Gross profit margin can be used to know the financial soundness of the business that projects how efficiently labor, material are being used. The gross profit margin remained above 50% in all the five years indicating that the company has a string hold on the cost of goods sold.
On the other hand, Net profit margin helps in focussing on the net profit that the company has earned. Higher net profit indicates a strong position of the company and projects the manner in which the expenses are tamed. It is defined as the ratio of net profit to revenue. It reflects the extent of dollar reaped by the company is converted into profits. The Net profit declined in the past years owing to the decline in the net income (Davies & Crawford, 2012). However, it remained positive in all the five years.
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
|
Net Profit Margin [(Net Profit after tax/Sales Revenue)*100] |
7.373271889 |
5.535314 |
2.42051 |
2.724381 |
2.743142 |
|
Gross Profit Margin [(Gross Profit /Sales Revenue)*100] |
52.47311828 |
54.69451 |
55.21341 |
56.06417 |
56.3591 |
2. Liquidity of GKN Plc
Liquidity ratio projects the ability of the company to honor the obligations. In short, it can be said that liquidity defines the resources of the company to cover the cash obligations and it determines the future of the company in the area of growth or performance issues through the inflow and outflow of money (Deegan, 2011).
Efficiency states the manner in which the assets of the company are being utilized. It denotes the measures that the company undertakes to profit from the resources. It is important to utilize the assets efficiently because in its absence the company will use the liquid funds and hence might fell in danger (Graham & Smart, 2012). The total asset turnover indicates the management is using the assets in a very efficient and prudent manner thereby leading to a high asset turnover ratio.
The liquidity of the company is projected through the current and the quick ratio that helps in ascertaining the liquidity of the company.
The current ratio is used to highlight the fund’s rotation through the business to make certain that the inventories, as well as debtors, are converted into cash to repay the creditors and is done by dividing the current assets by the current liabilities (Deegan, 2011).
The Quick ratio is better in comparison to the current ratio as it excludes stock. It projects that the liquidity of the stock will not be considered to honor the obligations. A standard ratio of 1:1 is considered the best for the company (Guerard, 2013).
The current and the quick ratio of the company is in a better position indicating the company has the liquidity to meet its obligations. In 2016 the current ratio stands at 1.31 moving close to the standard ratio of 2:1. Moreover, the quick ratio stands at 0.78 close to the standard ratio of 1:1 and hence will not fell short of funds.
|
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
Current Ratio (Current Assets/Current Liabilities) |
1.288617886 |
1.348511384 |
1.331059811 |
1.250891266 |
1.319220682 |
|
Acid Test [(Current Assets-Inventory)/Current Liabilities)] |
0.774680604 |
0.805020432 |
0.82161595 |
0.729500891 |
0.783064818 |
It is even termed as activity ratio as it helps in evaluating the manner in which the assets of the company are being utilized. Moreover, it sheds light on the manner in which the inventory is used to generate revenue. The most importantly used ratio is total asset turnover, equity turnover, and stock turnover ratio.
The inventory turnover ratio indicates how quickly the sales are generated with the help of the stock or inventory. The stock turnover ratio for GKN Plc indicates that the company was slow in terms of this ratio as it declined marginally indicating less number of times the stock was converted to sales in a year.
The total asset turnover indicates the manner in which the total assets of the company were utilized. A high total asset turnover is indicated a meaning that the management has utilized the assets in an effective manner.
|
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
Total Asset Turnover [(Net sales/Average total assets) × 100] |
103.8278 |
114.0939 |
108.0889 |
101.924 |
107.1151 |
|
Stock turnover ratio = Net sales/ Avg Inventory |
7.355932 |
7.859031 |
7.341746 |
6.754787 |
6.783545 |
The capital structure ratio is even defined as the leverage ratio and is those financial ratios that ascertain the long-term solidity and structure of the firm. The ratio projects the mix of funds that is provided by the owner and the lender and the lender of the long term funds are assured of periodic payment with interest and the repayment of principal on the date of maturity (Horngren, 2013).
The shareholder ratio can be termed as the return on investment and with this ratio, the determination of the dividend amount can be done that will be provided to all the investors after the equity return (Spiceland et. al, 2011). This brings the concept of ROE. ROE can be defined as defined as the ratio that helps in evaluating the return on capital that is invested into the company and projects the profit that will be generated by the company to compensate the risk of invested in the business (Horngren, 2013). Higher ROE accounts for a strong framework and projects strong stability. In the case of GKN Ltd, the ROE has dropped that indicates the chances of risk and lower returns.
The debt-equity ratio helps in evaluating the financial leverage and is computed by dividing the total debt by total equity. The debt-equity ratio indicates the level of debt that a company utilizes in its operations (Libby et. al, 2011). A higher level of debt over equity indicates that the company has a higher stress on debt and that higher proportion of funds will go towards payment of interest. Any proportion of debt above .50 raises the alert level because the company is relying on borrowed funds. In the case of GKN Plc, the company contains an optimum balance of debt equity and remained below .50 expect going above in 2012 and 2014. This is a strong indication that the company balance its performance on equity and not on debt.
|
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
Debt Equity Ratio |
0.595299 |
0.500845 |
0.592292 |
0.463768 |
0.394922 |
|
ROE = Net Income/ Shareholder equity |
30.49555 |
22.25352 |
11.42664 |
10.57434 |
11.37753 |
5. Market performance
It is a listed company and hence, market performance is of paramount importance as the investors are interested in it. The stock price movement of GKN PLC projects that it performed in a strong manner in the past 5 years and generated strong returns. It boasts of the string fundamentals of the company.
Earnings per share or EPS denote the profitability of the company. It is a computation that denotes the profitability on the shareholder side. Hence, larger company’s profit per share can be distinguished to a smaller share of profit (Melville, 2013). The calculation rests on the shares that are outstanding. The EPS of the company is in a positive zone and enhanced from year to year indicating that the investments were used in a favorable manner.
It is the dividend paid by the company. it is important in the sense that the main aim of the company is to provide a return to the shareholders. Investors are concerned about the dividend per share because it denotes the profit earned by the company and distributed to the shareholders. Further, it establishes goodwill of the company. A company that pays dividend enjoys immense benefits and shareholder value. The dividend per share of the company increased from 2012 to 2014 and then remained constant.
|
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
Earnings per share |
0.3 |
0.24 |
0.1 |
0.11 |
0.14 |
|
Dividend |
0.07 |
0.08 |
0.08 |
0.09 |
0.9 |
Limitations
The above comparison and detailed analysis have been done with the help of ratio analysis. It has provided immense knowledge about the functioning of the company and forecast for the coming days. However, it is crippled with some defects. Some of the major limitations of ratio analysis are as follows
Inflationary influence
The influence of inflation is left untouched and hence, the financial data are unable to provide a clearer view of the company. The assets that were purchased years back appear in the financial statement at their historical dates and values (Merchant, 2012). There is a vast difference between the current level and hence is defective in natur
Formula of ratio computation
Various methods are used in the computation of ratio and each has its own merits and demerits. A company uses the formula that best suits its needs. The same is evident in the case of GKN Plc. When it comes to the comparison of the ratio of different industry or same peer group it might lead to issues and misunderstandings because of the variation in the formulas
Quantitative measure
Ratios analysis is a quantitative measure and is best for the financial statements. But, it needs to be noted that the ratio is just an explanation or prediction of the state of things. It cannot provide a justification for what is absent. For example, the profitability ratio states the profit is low or high as compared to the previous year but unable to state the actual reason and the actions that can be taken to improve (Parrino et. al, 2012). However, calculating the ratios serves no purpose as true cause needs to be known.
Recommendations
From the computation and the above discussion, it can be commented that GKN Plc has established its position in the industry and is operating in a profitable manner. Going by the profitability ratio, the company can ensure a better net profit ratio by having some control on the operating expenses. The operating expenses in 2015 and 2016 have increased to a greater extent and this is why the net profit ratio has dropped. Hence, the management must have a strong control over the expenses.
Further, GKN Plc can ensure a better liquidity ratio. Though the company is not in a liquidity crisis yet it can make the ratio stronger so that any adverse circumstances can be met with ease and flexibility. The efficiency ratio can be considered and the stock turnover ratio can be enhanced that will lead to more inflow of funds. Lastly, it needs to look upon return on equity and debt equity ratio. It must enhance the ROE as it a vital ratio that is considered by the investors. It can enhance the level of debt to a little more extent that will help in the best combination.
Therefore by having an in-depth study of the ratios and financial statements it is clear that GKN Plc is a credible company and can be selected for investment in the long term due to its overall performance.
External sources of finance like debentures, loans, etc, are arranged from outside the business and internal sources of finance like preference shares, right issues, new issue, etc, are internally generated out of the company’s activity. Companies who prefer debt to equity utilize debentures because it is considered the cheapest mode of finance in comparison to equity. However, it does not share control with investors because the interest paid to debenture holders is tax deductible. It is advantageous because interest on debentures is a permissible expenditure and therefore, company tax is decreased (Brigham & Ehrhardt
, 2011). Further, it can be easily redeemed when surplus funds are available with the company. However, the cost of capital with debentures is immensely high and small public companies cannot purchase it because of its high denominations. Bank loans are also a relevant source of finance that has a rate of interest affixed to them. It varies over five years to possible twenty-five years. It is an advantage that bank loans can be easily secured and public companies can easily use such loans for conducting their businesses (Damodaran, 2012). However, the interest rates on bank loans can vary and are generally high. Further, it is a disadvantage that a guarantee is required for procuring such loan.
The right issue provides a path of raising new share capital by an offer means to the present shareholders and inviting them to subscribe cash for the new shares in the proportion to their current holdings. Companies making right issue must set a price that is minimal enough to secure the expectations of the shareholders (Choi & Meek, 2011). It is advantageous as troubled companies use such source to pay down debt, especially when they are incapable of borrowing more money (Arnold, 2010).
Further, existing shareholders obtain a right to purchase fresh shares at a discount on a specific future date. However, the value of each share becomes diluted because of an increased number of issued shares. In addition, it becomes easier for investors to get tempted by the perspective of purchasing discounted shares with a right issue. Companies make a new issue in order to raise finances for expanding their operations, or because they have become cashless and there is an immediate requirement of finance to continue existing operations. The main advantage of this source of finance is that it allows raising capital to smoothen current operations and secondly, it prevents companies from opting with debt financing that saves interest expenses (Brealey et. al, 2011).
However, the new issue is also problematic because, after this financing, the company becomes liable to share its profits with a wider pool of investors and the current owners lose much of the funds they have otherwise attained through revenues. Preference shares are a type of share that receives a pre-determined gain irrespective of the company’s condition (Damodaran, 2010). Moreover, the share value will remain the same and in the case of business liquidation, preference shareholders procure priority over other shareholders to get their money back.
Therefore, it is an advantage for preference shareholders as it is less risky in nature, is redeemable, and since they do not have voting rights, it is restricted from being diluted with the control of existing shareholders (Arnold, 2010). However, preference shares are also cumulative that means in the event of non-payment of dividend in a year, it gets carried forward to next year.
Several considerations must be considered while choosing the kind of finance to use. Firstly, the fee and interest structures of such sources must be considered because financing through investment can carry very different costs and add all associated costs with every financing method assists in making a decision. Secondly, the repayment terms must be considered because longer loans can enhance interest over time but shorter loans can require huge periodic payments (Williams, 2012). Lastly, the financing requirements must be considered in order to choose the best source of financing as it can cater to the company’s requirements in full.
2. Weighted average cost of capital (WACC).
Weighted average cost of capital of WACC is the rate that any company is expected to expend on aggregate to all its shareholders in order to finance its assets. It represents the minimal return that a company must attain on an existing base of assets in order to address the requirements of its owners, creditors, and other capital providers or they will invest at some other place. Moreover, it is generally referred to as the cost of capital of a firm that is illustrated by the external market and not by the management. WACC can be computed by considering the relative weights of components like debt, options, liabilities, etc, of the capital structure. Besides, the more complicated is the capital structure, the more problematic it is to compute WACC.
Since a company’s assets are primarily financed by either equity or debt, these directly affect the WACC of a company. The assumption that cost of debt is not equivalent to the cost of equity depicts that WACC is altered by a mere change in the capital structure (Albrecht et. al, 2011). Hence, being a combination of different costs that has to be paid on all the sources of finance, if there is a slight increase in the long-term source of debt, the WACC will be affected too. For instance, if the debt is increased from 50% to 70%, it signifies that level of equity will decline in the same proportion while calculating the WACC. In simple words, of a company desires to lower its WACC, it can opt to increase its use of a cheaper source of financing like debt (long-term). As the company can get financing more easily through debt, this could enhance the proportion of debt to equity, and since the cost of debt is relatively cheaper than equity, the WACC of the company would significantly decline.
References
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Arnold, G 2010, The Financial Times Guide to Investing, Prentice Hall.
Brealey, R., Myers, S. & Allen, F 2011, Principles of corporate finance, New York:
Brigham, E.F. & Ehrhardt, M.C 2011, Financial Management: Theory and Practice, USA: Cengage Learning.
Choi, R.D. & Meek, G.K 2011, International accounting. Pearson Press .
Damodaran, A 2010, Applied Corporate Finance: A User’s Manual, New York: John Wiley & Sons
Damodaran, A 2012, Investment Valuation, New York: John Wiley & Sons.
Davies, T. & Crawford, I 2012, Financial accounting, Harlow, England: Pearson.
Deegan, C. M 2011, In Financial accounting theory, North Ryde, N.S.W: McGraw-Hill.
GKN 2016, About GKN, viewed 5 March 2017, https://www.gkn.com/en/about-gkn/
GKN 2016, GKN Annual report and accounts, viewed 5 March 2017, https://www.gkn.com/en/investors/results-centre/annual-reports/
Graham, J. & Smart, S 2012, Introduction to corporate finance, Australia: South-Western Cengage Learning.
Guerard, J. 2013, Introduction to financial forecasting in investment analysis, New York, NY: Springer.
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Merchant, K. A 2012, ‘Making Management Accounting Research More Useful’, Pacific Accounting Review, vol. 24, no.3, pp. 1-34.
Parrino, R., Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ: Wiley
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